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Having searched for, and found, a 401(k) plan vendor — which is no easy task, as you learned in last month’s article “Eye on 401(k)” — you’re ready to move on to other things. But first, ask a few questions: How aggressively will you monitor your fund performance and costs? Do all of your eligible employees use the plan? Do they know how much they should be saving for retirement? Does your provider deliver daily services in a cost-effective way? Do you know how long it takes for your participants to get their account statements? Do you have a written investment policy for your plan?

True, you’ve outsourced a complex task to a specialist, but as experts are quick to point out, that does not relieve a plan sponsor from fiduciary liability for the plan, its operation, or its continued maintenance. “Once the particular function is outsourced,” says Scott Peterson, Hewitt Associates’s global practice leader for defined contribution services, “the plan sponsor should monitor that service provider constantly to make sure it continues to meet the promised service standards.”

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Constantly? Peterson says that discussing how service performance standards will be monitored over time is vital, and that ideally the discussions should take place during the selection process and in the course of the working relationship as well. “Performance standards should address the issues that are most important to the plan sponsor, everything from responsiveness to employee calls to what kinds of accounting controls will be used,” he says. “Having meaningful and measurable performance standards is a very important component in making sure that the plan operates properly over time.”

The 2000 Annual 401(k) Benchmarking Survey, conducted by Deloitte & Touche’s Human Capital Advisory Services Group, found that 86 percent of plan sponsors perform investment reviews at least once a year. In addition, there’s growing interest among plan sponsors in monitoring other, non-investment-related plan activities. “Increasingly, plan sponsors monitor such plan activities as the promptness of responses to questions that plan participants might have, as well as the ability of a vendor to provide error-free processing of transactions,” says Pat Jackson, director of the Deloitte survey.

Investments

Monitoring plan investment options to ensure that the funds perform up to the stated objectives is among the most critical aspects of performance measurement. It’s been a standard practice in defined- benefit administration to get routine quarterly reports from an independent consultant. The reports provide performance data, benchmark comparisons, and some analysis of why the vendor’s performance trailed or exceeded the benchmark. Defined-contribution plan sponsors need this information, too, in order to make informed decisions about retaining or replacing the incumbent investment managers (not necessarily synonymous with “service provider,” since some companies use one company for administration, another for investments, and so on).

In fact, at many companies, this form of monitoring entails group involvement. Tammy Evans, benefits manager at Techneglas Inc., a television-glass manufacturer based in Columbus, Ohio, says, “We have an employee benefits committee that oversees all of our benefits. We have an investment policy, and we keep very close tabs on the funds that we offer.”

The policy that Evans refers to is a written document that helps to assure that investments are made in a rational manner — it is also indispensable in monitoring plan activities, not to mention that it’s a key document requested by the Department of Labor (DoL) during plan audits.

Fred Reish, an ERISA (Employee Retirement Income Security Act) attorney and partner at the Los Angeles law firm Reish Luftman McDaniel & Reicher, says that while annual reviews are good, quarterly reviews are better, and that they should focus on three distinct aspects of the plan. First, plan sponsors should look at each of the plan funds to make sure they are still “superior-performing, reasonably priced funds,” he says. Then, plan sponsors need to make sure the investment options cover a broad range, so employees of any age or risk tolerance can build a retirement portfolio that meets their needs. Finally, at the big-picture level, plan sponsors should ask themselves whether the investment options in the plan are the kind that plan participants can prudently and intelligently use to build their retirement benefits. “If you have a whole bunch of aggressive funds and an unsophisticated workforce, this is clearly wrong,” says Reish.

If plan sponsors comply with ERISA’s 404(c) regulations, they do get some relief from responsibility for investment decisions made by the individual participants. But they still retain responsibility for ensuring that the participants have appropriate asset classes in which to invest, selecting competent investment managers for the various investment options, routinely monitoring and evaluating investment performance, and controlling costs, which are typically borne by the plan participants.

Plan sponsors have a fiduciary responsibility under the guidelines of ERISA to make sure that the plans are managed in a cost-efficient manner, without detriment to the participants. Several years ago, the DoL embarked on an initiative to stress to plan sponsors the importance of ensuring that the vendor fees paid by 401(k) plan participants are reasonable. “The DoL is continuing to fire up the stove in terms of looking at fees and making sure they are competitive,” says Dan Esch, managing director at Minneapolis-based Defined Contribution Advisors. “Since it’s the plan participants in the defined contribution plans who end up paying the vast majority of fees, the DoL has a keen interest in understanding what level of fees participants may be paying from one vendor to the next.” The DoL, in conjunction with a number of trade organizations, issued a model 401(k) fee-disclosure form designed to help plan sponsors understand investment fees and expenses and to facilitate comparison of competing providers’ plan services.

Do the Due

Many 401(k) consultants offer similar forms. David Wray, president of the Profit Sharing/401(k) Council of America, a Chicago-based trade association of plan sponsors, says his firm encourages everyone in the RFP (request for proposal) process to use its worksheet to compare apples to apples. “If there is ever a question of why you chose a particular vendor, you can say you performed the due diligence on fee disclosures,” he says. “It’s important because every plan has its quirks, and companies have to ensure that a vendor can accommodate any unique plan-design features.”

To better manage fees, it’s necessary for plan sponsors to have a clear understanding of the costs a plan incurs. The DoL has identified three types of fees associated with 401(k) plans: the administration fee, the investment fee, and the individual service fee.

The administration fee includes recordkeeping, accounting, and legal and trustee services. The investment fee includes plan asset management, sales charges, commissions, an investment advisory fee, and mutual fund management services. Individual fees are charged directly to the plan participant’s account for special plan features like loan origination and loan maintenance fees. While that may sound like a lot to evaluate, 90 percent of respondents to Deloitte’s survey believe they have a clear understanding of the total fees being charged, and 84 percent think their fees are competitive.

Deloitte’s Jackson emphasizes the importance of assessing the totality of the fees that are charged by vendors. “Plan sponsors should look for total plan fees to be less than 1 percent of total plan assets,” she says. Fees should be assessed annually to ensure that they are competitive and reflect the level of services being offered.

Jackson says that often the most visible fees are the direct charges, such as the per-participant account fee, or transaction-based fees, such as the fee participants pay if they take out a loan. While direct fees are easy to monitor and compare with the marketplace, she says, plan sponsors often overlook indirect fees, which are investment management fees. “They are typically netted out of returns of investment funds or out of the asset values on mutual funds, and often fall under the venue of investment monitoring,” says Jackson. Increasingly, she adds, investment fees are becoming a significant part of the charges accrued for servicing 401(k) plans. Indeed, notes HR Investment Consultants, in Baltimore, for most mature plans, investment management fees represent more than 85 percent of total plan costs.

According to the Deloitte study, 70.4 percent of the sponsors responding pay the bulk of fees related to recordkeeping and administration. As far as investment management fees are concerned, 54 percent of plan sponsors indicated that they pass investment management fees on to plan participants by deducting them from their investment returns; 3.8 percent charge employees directly for investment management; and 42.2 percent of sponsors pick up investment management fees.

Paper Chase

Recordkeeping, which includes processing distributions and fund transfers, allocating contributions and earnings to participants’ accounts, and enrolling new participants, among other things, is one of the most critical but often overlooked functions of a 401(k) plan. “Often, plan sponsors choose a vendor without due diligence, without making sure that a particular vendor is capable of handling a particular plan. Plans differ in terms of complexities,” says Esch. “For example, companies that offer their own company stock have different issues, from an administrative point of view, than companies that don’t.”

Wray of the Profit Sharing/401(k) Council of America puts it more strongly. “If you drop the ball on the recordkeeping, you’re gone,” he says. “The key to this whole system is that there’s an expectation that you have accurate, timely, quarterly statements.”

Evans of Techneglas knows that firsthand. “With our previous recordkeeper,” she says, “employees would take out loans and the recordkeeper would forget to tell us, so we wouldn’t take repayment out of their paychecks and the loans would default. We couldn’t afford to make those kinds of mistakes. We have a fiduciary responsibility, and part of that is to make sure the recordkeeper is doing the job.”

But the company learned. “We’ve put several checkpoints in place,” says Evans. “We get monthly trust statements from our recordkeeper, and we pay for an internal audit to make sure that we, as well as the vendor, do a good job.”

When Patricia Gondolfo took over as CFO of Mount Kisco (New York) Medical Group, her review of the company’s 401(k) plan revealed that the funds offered by the vendor were great, but its recordkeeping was a mess. When she decided that the only solution was to take the business elsewhere, she says, “We didn’t go into the market and say, ‘Who’s got the best financial performance?’ and try to shoehorn in recordkeeping. It had to be a well-integrated service; recordkeeping had to be something they were doing in-house, and doing well.”

Experts agree it’s good to monitor the plan in terms of overall participant satisfaction, and that’s exactly what Rich Novak, vice president of human resources at Guilford Mills, is doing. “We log all employee complaints,” he says of the Greensboro, North Carolina, textiles manufacturer, “and if we find out that statements are not issued on time, or that there are other problems, we will be discussing remedies with our vendor.”

Talking It Out

What about employee communication? What do you do in terms of boosting plan participation and helping participants make informed investment decisions? Sponsors are increasingly demanding more than a measly brochure or newsletter. Today, in addition to call centers with live operators and automated response systems, they ask for Web-based financial-modeling tools to allow employees to explore their individual objectives.

Another increasingly popular service is automatic enrollment, in which an eligibility date and savings rate are determined in advance. When an employee becomes eligible for the plan, pretax deferrals take effect. Although currently in use at only 11 percent of plans, the practice is becoming more common, and can provide a big boost to participation rates. Web-based enrollment services are yet another way in which Internet technology is reshaping the defined contribution arena.

“If the services aren’t technologically up to speed,” says Jackson, “that’s a reason to start looking for a new vendor. Plan participants should have the opportunity to access their accounts and perform transactions via the Internet, and plan sponsors should also have the opportunity to access information and run reports and investigate performance of the plan on [a separate] plan-sponsor Web site.”

In addition to Web access, the availability of phone reps to respond to detailed questions from plan participants is becoming important, according to Jackson. “Many companies have employees spread across many time zones, and some call centers may not be open for more than 8 to 12 hours. Some vendors have responded by providing weekend or extended hours,” she says.

Strong employee communication and support systems are critical if most of the workforce consists of employees who lack sophistication in dealing with the market or who don’t speak English. “The investments don’t matter and the returns don’t matter if the people aren’t participating,” says David Huntley, principal of HR Investment Consultants.

Gondolfo agrees. She recalls with dismay what her assessment of Mount Kisco’s plan revealed: “When I got there, 30 percent of people’s retirement assets were in cash in the biggest bull market,” she says. “In this climate, where people can sue you over a retirement plan performance, you have an obligation as an employer to monitor not only financial performance, but also a vendor’s ability to communicate with plan participants in an effective way so that they have an understanding of the account and what’s in it.”

Since Gondolfo took over, monitoring of different aspects of the plan has been refined. “I have a pension committee that oversees the choices and the lineup of investments,” she says. “The accounting arm oversees individual calculations and accounts to validate them, not just send us the file for 2000. My accounting staff still goes through that to make sure there are no errors.” Internal controls are a priority, she says. The company also has an external auditor that does random sampling as a backup. “I don’t think that you can have too much auditing,” says Gondolfo. “That’s from my experience of walking into something that was a mess.” Needless to say, it won’t become a mess again, as long as every aspect is being monitored appropriately.

Meg Glinska is a freelance writer based in Boston.

Tips for Smarter Shopping

Plan fees and expenses merit scrutiny.

1. Have you decided which fees and expenses you, as plan sponsor, are going to pay, and which will be charged to plan participants?

2. Do you know which services are covered under the base fee and which incur an extra charge?

3. Do you know which fees and expenses are charged directly to the plan and which are deducted from investment returns?

4. Do you know that some investment options have higher fees than others?

5. Does your service contract with your vendor spell out any restrictions, such as charges for early termination with the provider?

6. Do you know what information you will receive on a regular basis from your service provider so that you can monitor the provision of services and the investments you’ve selected, and make changes?

7. DO YOU KNOW how the fees you and your plan participants are paying compare with the marketplace?